The Impact of Verifiability on the Reliability of Fair Value Estimates: Evidence from the Level 3 Rollforward Disclosure

Abstract

Using hand-collected data from the Level 3 reconciliation disclosure, I study the impact of verifiability on the perceived reliability of changes to fair value estimates. Using a value relevance framework, I find that investors perceive indirectly verifiable changes to Level 3 fair value holdings as less reliable than directly verifiable Level 3 changes. I next show that, consistent with a Bayesian updating framework, the value relevance of indirectly verifiable changes is moderated by the overstatement of prior fair value estimates, and by the recency of the investment’s acquisition. My study provides new insights on how investors price fair value estimates and also contributes some of the first empirical evidence on the positive relation between the enhancing qualitative characteristic verifiability and investor perceptions of the reliability of information. Relatedly, my study highlights the difference between verifiability and the ASC 820 characteristic observability and finds that observability does not capture investor perceptions of reliability. Finally, the results of my study contradict recent claims that the ASC 820 disclosures are uninformative.